Don't Blame Employers For High Medical Costs

In a recent New York Times blog, Uwe Reinhardt places much of the blame for high and rising medical prices on passive employers. He argues that employers should work just as hard to reduce healthcare benefit costs as they work to reduce other input costs. But he then observes:

"One reason for the employers' passivity in paying health care bills may be that they know, or should know, that the fringe benefits they purchase for their employees ultimately come out of the employees' total pay package. In a sense, employers behave like pickpockets who take from their employees' wallets and with the money lifted purchase goodies for their employees."

I think that Reinhardt gets the economics wrong here and, in the process, he puts too much of the blame on employers. Reinhardt is right in one respect - employees care about their entire wage/benefit packages. If benefits deteriorate, employers will have to increase wages to retain workers. Thus, it seems that if an employer reduces benefit costs, it must increase wages by an equal amount. If that is true, we can understand why employers are passive.

The correct economic argument is a bit more nuanced. Employees do not care about the cost of their benefits; they care about the benefits. If an employer can procure the same benefits at a lower cost, the employer need not increase wages one iota. In this regard, there is nothing special about health benefits. Suppose an employer offers employees the use of company cars. Workers don't care what the employer paid for the cars, and if the employer can purchase cars at a deep discount, it will pocket the savings.

Reinhardt may be wrong about the underlying economics, but he is correct in the big picture. Employers may have an incentive to reduce benefits costs yet they are passive purchasers. With a few exceptions, nearly every American corporation outsources its healthcare benefits to insurers and ASO providers and then looks the other way as the medical bills pile up. Sure, they complain about the high cost of medical care, but they don't take direct action by aggressively shopping for lower provider prices. Doesn't this passivity demonstrate a lack of interest? No more so than the fact that auto makers do not aggressively shop the lowest rubber or silica prices implies that they are disinterested in the costs of tires and windows. Auto makers outsource the production of tires and windows (and most other inputs) and let the Michelins and PPGs of the world worry about rubber and silica prices. By the same token, American companies outsource the production of insurance and let the Blues and Uniteds of the world worry about provider prices. This is entirely appropriate.

Could employers do more to reduce healthcare spending? Employers have dramatically increased deductibles in recent years, and this has had some effect (though no one is certain just how much.) Employers tried forcing employees into narrow network plans in the 1990s, mostly in the form of HMOs, but employees rebelled against the lack of choice. (Some of you may remember the "Patients' Bill of Rights" that Congress nearly enacted.) I don't expect too many employers to repeat that mistake. Employers might offer cheaper plans alongside expensive ones, but they probably won't pass most of the savings on to employees. For one thing, employers want to keep most of the savings for themselves. Perhaps more problematically, there is a growing body of evidence that this could lead to an adverse selection death spiral that would disrupt employee choices.

It is hard to imagine that American businesses have been willfully negligent about healthcare spending. If only by accident, some employers would be worried about health spending. And if worrying about costs was enough to actually lower costs, then those that worried would outperform their competitors and gain market share. By now, every American would be working for a company that worried about health spending. The logic is pretty compelling: America's firms are worried about health spending and are appropriately outsourcing these worries to insurers.

So why are medical costs and medical prices so high? I could give a list but this has been discussed ad nauseum so I will not repeat it here. Employer-sponsored insurance is on the list, but largely due to tax deductibility. If employers are otherwise on the list, they are towards the bottom.